Passive investment is the most reliable way to grow your wealth if you do it smart. All you need is a plan, self discipline to stick to it and patience to wait for your investment fruit to ripen. In the following article I’m aiming to help those who do have the dedication to invest in their financial future, but hesitate where to start. Some people might find passive investment strategies boring, but if you do not wish to spend much more time on finances than 5 minutes per month, this might be the best option for you.
Things to Consider Before Starting to Invest
The most important thing you need to have is a plan. Depending on your personal situation, there are two main things to consider before choosing the best passive investment strategy for yourself.
There are endless reasons why you might want to start investing. You might simply want to increase your wealth over time. Maybe you have a shorter term goal, like collect the necessary down payment for your first home. Or you want to build up a college fund for your child. No matter what is your particular aim, you need to decide on the time frame of your investment. Time is probably the most important factor when it comes to passive investment.
Generally speaking the longer your investment horizon is, the more risk you should take.
- If you wish to invest for over 15 years, you definitely should go all-in with stocks. The best way to invest in the stock market in a passive way is via low cost index ETFs. The best choice might be the Vanguard Total Stock Market ETF (VTI). Via this you can invest in every publicly traded companies in the US. This is probably the easiest way of diversification, In addition this ETF has only a minimal, 0.05% expense ratio. Please check out my earlier post on the importance of expense ratio. Besides of VTI, you might also consider these other, dividend focused ETFs.
- If your investment horizon is a bit shorter, you might want to smooth the volatility and decrease the overall risk by adding some bonds to your portfolio. VTI also has its “bond counterpart”, the Vanguard Total Bond Market ETF (BND). This fund invests about 30% in corporate bonds and 70% in U.S. government bonds of all maturities. For a bit higher risk (but also higher returns) you might also consider adding some emerging markets bond ETF. I personally invest in the PowerShares Emerging Markets Sov Dbt ETF (PCY). The ratio of stocks and bonds in your portfolio should depend on your time frame and risk tolerance. For a 8-10 years investing period you could consider the “classic” 60-40% allocation.
- If you wish to invest for under 5 years, you should minimize your stock exposure and invest instead in bonds. Bear in mind that you can also lose money on bonds, especially in the current low and rising interest rate environment. The shorter your investment horizon is, the more shorter maturity bonds you should keep in your portfolio. In such case your returns will be also lower. The Vanguard Intermediate-Term Bond ETF (BIV) holds investment-grade bonds with a dollar-weighted average maturity of 5 to 10 years, while this metrics for the Vanguard Short-Term Bond ETF (BSV) is 1 to 5 years.
2. Amount to Invest
The most effective passive investment strategy is to invest regularly. You need to determine how much can you invest each month and try to stick to this plan. It is a very useful method if you immediately make your monthly investment right after you get your monthly salary. If you have extra money left at the end of the month, consider adding this amount to the investment of next month.
The exact amount that you can/should invest highly depends on your financial situation and lifestyle. The purpose of this article is not to suggest how to determine this amount. Why it is still important to talk about the amount is the cost of investment. Your broker will charge a transaction fee. If this fee is 10 per transaction, but you can invest 200 per month, the expense of your investment will be 5% which is huge.
This of course does not mean that you should not consider investing if you can only save a small amount per month. But in such cases you should consider putting aside your monthly savings to a saving account, and invest the accumulated amount in let’s say every half year. The same transaction fee of 10 will represent only 0.8% in case you invest 1,200.
Things to Do After Investing
We are talking about passive investment strategies here, so this part will be easy. For most of the time you do nothing. The most important thing is to stick to your plan. Don’t care about market movements, don’t panic when the price declines (be happy that you can buy cheaper)! Exclude emotions from investment decisions!
In case you have a portfolio of mixed assets, it can be a smart idea though to re-balance it once a year. What does it mean? Let’s say your target is to have a portfolio of 60% stocks and 40% bonds. In case of a stock market rally, you might find your portfolio having 70% stocks and 30% bonds at the end of the year. In such case you might consider selling some of the stocks (or stock ETF) and buy bonds instead. Alternatively you can also focus on buying bonds only during the first few months of the following year until the ratio reaches your desired percentage.
The Result of Passive Investment
Of course the most obvious result will be that you will notice your investment value growing over time. After a while you will realize that besides your monthly savings, your investment will provide extra returns as well via distributions. You should also add these returns to your investment and slowly but steadily the compounding effect will start working.
After a couple of years you will notice that the returns of your investment will even exceed the amount you are saving from your salary. You have made a money making machine and the limit is the sky! 🙂
As an additional result you will also gain something that cannot be measured by money (no, I’m not talking about weight 🙂 ). I’m talking about financial awareness which is an extremely valuable asset in life. Being financially aware is a way of thinking and a way of lifestyle. It does not depend on your financial situation, but does have effect on your future financial situation. A poor person with financial awareness can increase his wealth, while a rich one without such ability might lose everything.
Passive investment might not be for everyone. It is boring, it is definitely not a get rich fast scheme, but this is exactly what makes it work. You do not need to have any financial background, you do not need to have large starting capital. As I said all you need is a plan, self discipline and patience. The rest will come passively 🙂
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Disclaimer: This post or any other information on the site is not intended to be and does not constitute financial advice or any other advice. I am solely sharing my idea, plan and progress on early retirement.